How Would Capital Account Liberalization Affect China's Capital Flows and the Renminbi Real Exchange Rates?

26 Pages Posted: 7 Dec 2012

See all articles by Dong He

Dong He

Hong Kong Monetary Authority; Hong Kong Institute for Monetary Research (HKIMR)

Lillian Cheung

Hong Kong Monetary Authority

Wenlang Zhang

Independent

Tommy T. Wu

Hong Kong Monetary Authority

Date Written: November‐December 2012

Abstract

In this paper we study the determinants of gross capital flows, project the size of China's international investment position in 2020, and analyze the implications for the renminbi real exchange rate if China liberalizes the capital account. We assume in this exercise that the renminbi will have largely achieved capital account convertibility by the end of the current decade, a timetable consistent with recent proposals by the People's Bank of China. Our analysis shows that if the capital account were liberalized, China's gross international investment position would grow significantly, and inflows and outflows would become much more balanced. The private sector would turn its net liability position into a balanced position, and the official sector would reduce its net asset position significantly, relative to the country's GDP. Because of the increasing importance of private sector foreign claims and the decreasing importance of official foreign reserves, China would be able to earn higher net investment income from abroad. Overall, China would continue to be a net creditor, with the net foreign asset position as a share of GDP remaining largely stable through this decade. These findings suggest that the renminbi real exchange rate would not be particularly sensitive to capital account liberalization as capital flows are expected to be two‐sided. The renminbi real exchange rate would likely be on a path of moderate appreciation as China is expected to maintain a sizeable growth differential with its trading partners.

Keywords: capital account liberalization, exchange rates, net foreign asset position

JEL Classification: F21, F31, F37, O24

Suggested Citation

He, Dong and Cheung, Lillian and Zhang, Wenlang and Wu, Tommy T., How Would Capital Account Liberalization Affect China's Capital Flows and the Renminbi Real Exchange Rates? (November‐December 2012). China & World Economy, Vol. 20, Issue 6, pp. 29-54, 2012. Available at SSRN: https://ssrn.com/abstract=2186289 or http://dx.doi.org/10.1111/j.1749-124X.2012.12001.x

Dong He (Contact Author)

Hong Kong Monetary Authority

3 Garden Road, 30th Floor
Hong Kong
Hong Kong

Hong Kong Institute for Monetary Research (HKIMR)

3 Garden Road, 8th Floor
Hong Kong
China

Lillian Cheung

Hong Kong Monetary Authority ( email )

3 Garden Road, 30th Floor
Hong Kong
Hong Kong

Wenlang Zhang

Independent ( email )

No Address Available

Tommy T. Wu

Hong Kong Monetary Authority ( email )

55/F, Two International Finance Centre
8 Finance Street, Central
Hong Kong
Hong Kong

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